Our Views
I think right now the Fed feels like it is in the right zone for rates, so CEOs can get more confident. Last year, they couldn’t because the Fed was on this massive raising cycle and they expected a recession to come. But that’s not the case now. So I think business confidence is going to improve over the next six months. The Fed’s decision is also going to allow market breadth to expand. Let’s remember that the P/E for S&P500 ex-FAANG is at about 15x. I think you’re going to see some action there in the next six months.
The Fed meeting was interesting. It’s funny because they did a hawkish pause, but then Powell was really firm that over half of the Committee voted for two more rate hikes. And two people wanted three more rate hikes, which was interesting, because if that was the case, why didn’t they just hike yesterday? Honestly, I suspect that all that harsh rhetoric will ultimately turn out to be nothing more than that once the data comes in. Because I think the data is going to start to come in easy.
I originally turned hawkish on the Fed in late March/early April of 2022, and at that time my view was that Chair Powell and Gang would 1) hike until they broke something (regional banking crisis – SIVB/FRC, etc.); 2) have a long battle to get inflation back to the 2% target; 3) stay higher for longer; and 4) ultimately, push the US economy into a shallow recession. My view is unchanged since then, and I still think that no Fed easing is imminent. In my opinion, this will continue to contribute to a risky equity environment, especially for the broader market, which I am defining as the S&P500 ex- the magnificent 7, the S&P 500 equally weighted, and the Russell 2000. The weakest quarters for economic growth are still likely ahead of us, and Smid cap, Lower quality, and more cyclical look the most at risk. I still prefer a mix of LC, Higher Quality, Secular Growth and some defensive areas.
I’m speculating, but I think when the FOMC minutes come out on July 6, they will show that there was some real dissent about whether to hike in the future. I think the minutes are going to show that there was real dissent from people who probably raised the point about inflation having already peaked.
A Hawkish Pause, But What Comes Next?
Ahead of FOMC day, Head of Research Tom Lee noted that many investors were viewing the market from the lens of a conventional monetary policy cycle, leading them to expect a hard landing and remain leery of stocks until at least three or four rate cuts by the Fed. Instead, Lee has argued that inflation is the key story arc for equities.
FOMC day was preceded by the Bureau of Labor Statistics May CPI release. “The details were better than expected,” Lee wrote on Tuesday, and likely “good enough to keep the Fed on pause for June and possibly in July as well.”
As he noted, ex-shelter, the sticky Core CPI is now at 2.5% 3M SAAR (3-month annualized), which is nearly on target.
The Fed’s dot plot appeared to tell a different story – of the 18 FOMC members, 16 saw at least one more hike in this cycle, and a slight majority saw two or more hikes. But, the Fed’s press statement described this month’s pause as a chance for committee members “to assess additional information and its implications for monetary policy.”
After the decision announcement, Fed Chair Jerome Powell said “the U.S. economy slowed significantly last year” while pointing out that “recent indicators suggest that economic activity has continued to expand at a modest pace.”
Or, as Lee put it, “Instead of a recession unfolding, it looks like the economy is slipping into an expansion.”
Lee had anticipated the possibility of a hawkish pause on Monday, but he said that such a pause would not durably hurt equities for the rest of the year. In fact, it didn’t even hurt equities much for the rest of the day – the S&P 500 ended Wednesday slightly higher. After the decision, Lee added, “This is essentially a green light for markets to continue to rally, and I think this is a green light for market breadth to expand.”
The next meeting of the FOMC is July 25-26.
